Financial Analysis Of British Petroleum And Royal Dutch Shell Corporations

Understanding financial accounting problem and proposed solution structures

The present report is developed to demonstrate the significance of carrying out financial analysis in order to develop an understanding of the financial problems faced by an organization and develop effective strategies for their resolution. Financial analysis is a crucial key for an organization for evaluating its performance in context of financial management and thus assessing its financial position as per particular time period. The financial performance, position and the growth of an organization could easily be evaluated through financial analysis.

Financial analysis is done by the professionals for investor perspective, customer perspective, supplier perspective etc to assist them to make a decision about the company. Financial analysis process includes various methods to manage and evaluate the financial statement of an organization such as ratio analysis, vertical analysis, horizontal analysis, capital asset pricing method etc. In this context, the report is developed to carry out the financial assessment of the companies British Petroleum and Royal Dutch/Shell Corporations in order to identify their abilities for sustaining the profitability in the situation of a financial crisis period. The financial performances of the two companies are evaluated through the use of ratio analysis by adopting the use of financial statements published by the companies during the period of 2014-2016. The report assesses the financial performance of the selected companies in context of the financial crisis period. The financial crisis has also impacted largely the performance of both the companies and as such this report is developed to provide recommendation to them for sustaining their profitability in the situations of financial crisis. In addition to this there will discussion on concepts and techniques of strategic management accounting and costing for promoting the development of both the companies in the future period of time.

British Petroleum is regarded as one of the major Oil and Gas Company headquartered in London. The company is involved in providing customer’s fuel, energy, lubricants and petrochemicals and carries out its operations in about 70 countries worldwide. The company is recognized to be one of the largest Oil and Gas Company in terms of revenue having a market capitalization of about $129.3 billion. The company provides employment to about 80,000 people across the world having a total asset base of about $272 billion. It carries out its activities under the two major segments of upstream and downstream operations. The upstream operations involve production of oil equivalents while downstream operations involve the development of petrochemicals, lubricants and fuel. The revenue of the company is reported to be about $135.63 billion at the end of the year 2017 having about 19.7 billion of ordinary shares outstanding at the end of the year that are publicly traded on London Stock Exchange (BP Annual Report, 2015).

Components of financial statements and efficient financial reporting

Royal Dutch Shell is also a recognized British multinational oil and gas company headquartered in Netherland. The company is also attributed to be large in terms of revenue estimated to be about $265 billion and is known to be one of the largest oil and Gas Company of the UK. The company carries out its operations on the basis of three segments, that are, upstream, downstream and corporate. The upstream segment is engaged in exploration, liquefaction and transportation of crude oil and natural gas. The downstream segment is involved in manufacturing, supply and distribution of oil products, chemicals and carbon dioxide management. The corporate segment involves the support functions of the company comprising of holdings, treasury and self-insurance activities.  It is a strong competitor of British Petroleum in the UK involved in large-scale production and distribution of crude oil, natural gas, transport oil and other natural gas liquids (Royal Dutch Shell plc, 2016).

The report briefs about the financial crisis. Financial crisis has affected the entire economy and market of UK. Huge impact has been done on the UK financial market. Before UK financial crisis, the position of the company was quite strong but due to the crisis, the investors have lose their interest into UK market and thus the economy of the country has been impacted. The report explains about the two companies, BRITISH PETROLEUM PLC and ROYAL DUTCH/SHELL CORPORATIONS PLC. In the study, financial analysis has been done on both the companies to evaluate the financial performance as well as risk position of the company.

The four major qualitative characteristics of financial reporting are understandability, comparability, verifiability and timeliness. The financial reports developed by business entities should meet all these qualitative characteristics for improving the decision-making usefulness of the financial information presented in the reports. As such, it can be stated from the financial assessment carried out of the companies, British Petroleum and Royal Dutch Shell, that it has meet all the criteria’s of financial reporting. The financial assent carried out with the help of ratio analysis technique contains the understandability characteristic of financial reporting. This is measured by depicting the percentage change in the financial performance over the years 2014-2016 and also illustrating it by graph for facilitating its easy understanding. As per comparability characteristics, the financial information is comparable by assessing it from previous year performances as ratio analysis has been carried out for a period of three consecutive financial years. The assessment is carried out from the financial information extracted from the annual reports of both the companies which makes it verifiable. At last, the financial assessment has met timeliness characteristics of financial information as it has depicted the most recent performance of the selected companies therefore increasing its usefulness for the decision-makers (Brealey, Myers and Marcus, 2007).

Analyzing company performance and financial position

The profitability analysis of both the companies is carried out for assessing their performance at the end of a particular financial period. The analysis of the profitability position of both the companies is carried out by assessing their performance in terms of return on shareholder, operating profit and gross profit margin.

• Operating Profit Margin: The operating profit margin ratio indicates the profit realized by a company after meeting all its variable costs such as wages and raw materials. It can be calculated through dividing the net operating profit by net sales that occurred during the financial period. The operating profit margin ratio of BP has shown a decreasing trend during the financial period of 2014-2016 from 1.38% to (-) 1.23%. RDS has also depicted a declining trend during the period from 6.56% to 2.34%. Thus, it can be said that both the companies’ variable cost of production are increasing leading to decline in their operating profitability. As such, they are recommended to develop effective strategies for reducing the variable cost of production by improving the operational efficiency (Brigham and Michael, 2013).
• Return on Shareholder Fund: The ratio provides a measure of the ability of a company to use the shareholder funds for generating profit. It is calculated through dividing the net income by shareholder’s equity. The calculation of the return on shareholder funds ratio of BP from the year 2014-2016 has depicted that they have experienced a sharp decline in their net worth over the financial period. The ratio of BP has been declined from 3.39 % to 0.12% while that of RDS have shown a decrease from 8.65% to 2.45% during the financial period. Thus, it can be said that the ability of both the companies to earn profits on the shareholder investment have shown a decreasing trend and this is a major issue of concern for them.
• Gross Profit Margin: The gross profit margin ratio of a company indicates its total revenue realized by meeting the direct cost of production. It can be analyzed from the gross profit margin ratio of both the companies that BP have maintained a steady growth in the ration year the period from 13.77% to 13.56% while RDS have depicted an increasing trend of the ration from 17. 16% to 20.42%. This can be stated to be good for the future financial growth of both the companies (Bromwich and Bhimani, 2005).

Description	Formula	ROYAL DUTCH SHELL PLC
		2016	2015	2014
Profitability
Return on shareholder funds	NPAT/ Total equity	2.45%	1.19%	8.65%
Operating profit margin	Operating net profit / Sales	2.34%	0.75%	6.56%
Gross Profit Margin	Gross Profit / Sales	20.42%	18.16%	17.16%

(Royal Dutch Shell plc, 2015 and 2016)

Description	Formula	British Petroleum PLC
		2016	2015	2014
Profitability
Return on shareholder funds	NPAT/ Total equity	0.12%	-6.67%	3.39%
Operating profit margin	Operating net profit / Sales	-1.23%	-4.24%	1.38%
Gross Profit Margin	Gross Profit / Sales	13.56%	10.69%	13.77%

(BP Annual Report, 2015 and 2016)

The liquidity analysis depicts the ability of a company to meet its financial obligations and is examined for both the selected companies through measuring their current ratio and acid-test ratios.

• Current Ratio: The current ratio provides a measure of the ability of a company to meet its liabilities with its assets. Thus, it provides a rough estimate of a company financial health and its financial performance in the future period of time. The current ratio is calculated through dividing the current assets by current liabilities. It can be said from measuring the current ratio of BP from the financial year 2014-2016 that it has shown a somewhat declining trend from 1.37 to 1.16 over the period while that of RDS have depicted somewhat increasing trend from 1.16 to 1.17%. Therefore, it can be said that RDS current asset base is larger in comparison to that of BP (Bui, Petersen, Poulsen and Gazerani, 2016).
• Acid test ratio: It is also known as quick ratio and provides an assessment of the financial ability of a company to meet its financial obligations from its cash or quick assets that can be converted into cash immediately. The acid test ratio of both the companies, that are, BP and RDS have shown a decreasing trend over the years 2014-2016. The ratio of BP has depicted a decline from 1.08% to 0.86% while that of RDS have shown a decrease from 0.93 to 0.88%. This can be a major issue of concern for both the companies as their abilities to meet their financial obligations from the cash inflow are decreasing.

Description	Formula	ROYAL DUTCH SHELL PLC
Liquidity		2016	2015	2014
Current ratio	Current assets/current liabilities	1.17	1.32	1.16
Acid test ratios	Current assets-Inventory/current liabilities	0.88	1.09	0.93

(Royal Dutch Shell plc, 2015 and 2016)

Description	Formula	British Petroleum PLC
Liquidity		2016	2015	2014
Current ratio	Current assets/current liabilities	1.16	1.29	1.37
Acid test ratios	Current assets-Inventory/current liabilities	0.86	1.03	1.08

(BP Annual Report, 2015 and 2016)

The efficiency ratio analysis is carried out in order to analyze the abilities of both the companies to use their assets and liabilities internally well and generate sales and is assessed through the calculation of the following ratios:

• Receivables Collection Period: The calculation of the period provides an assessment of the outstanding receivables of a company in relation to its total sales and thus its ability to collect its accounts receivables. It is calculated by dividing the accounts receivable turnover by the number of days in the period. The collection period of BP is showing an increasing trend over the years 2014-2016 from 32.78% to 43.28% while of RDS have also increased from 34.30% to 53.98%. Thus, it can be said that the ability of both the companies to collect their accounts receivables are increasing which is not good for their future financial growth and development (Madura, 2014).
• Payables Collection Period: The period provides an assessment of the companies’ ability to pay its invoices from trade creditors or suppliers. It is calculated by dividing the average accounts payable by the average cost of sales in the period. The payables collection period of both the companies that are BP and RDS have shown an increasing trend. This does not depict a point of good financial growth for the companies as they are taking longer time to meet their financial obligations (Damodaran, 2011).
• Inventory days: It provides a measurement of average number of days a company holds its inventory before selling it. This ratio of both the companies have shown an increasing trend depicting that both the companies are holding their inventories for longer period of time before converting it to sales. This can lead to increase in the operational cost of both the companies and therefore it is advisable for them to reduce the inventory days (Davies and Crawford, 2011).

Description	Formula	ROYAL DUTCH SHELL PLC
Efficiency		2016	2015	2014
Receivables collection period	Receivables/ Total sales*365	53.98	39.44	34.30
Payables collection period	Payables/ Cost of sales*365	53.64	38.99	–
Inventory days	Inventory/ cost of goods sold *365	41.61	25.93	20.12

(Royal Dutch Shell plc, 2015 and 2016)

Description	Formula	British Petroleum PLC
Efficiency		2016	2015	2014
Receivables collection period	Receivables/ Total sales*365	43.28	37.46	32.78
Payables collection period	Payables/ Cost of sales*365	48.82	30.45	27.23
Inventory days	Inventory/ cost of goods sold *365	39.95	25.58	21.68

(BP Annual Report, 2015 and 2016)

• Gearing Ratio:The gearing ratio provides a measure of the financial performance of a company by comparing the owner equity to that of funds borrowed. It is calculated by dividing the long-term debt level of a company over the owner equity. The Gerang ratio of both the companies have shown an increasing trend over the year 2014-2016 and thus indicates that both the companies are utilizing more equity funds in comparison to the debt for financing their assets (Krantz, 2016).

Description	Formula	ROYAL DUTCH SHELL PLC
Gearing Ratios		2016	2015	2014
Gearing	Non-current interest bearing debt / non-current interest bearing debt + equity	0.27	0.24	0.18

(Royal Dutch Shell plc, 2015 and 2016)

Description	Formula	British Petroleum PLC
Gearing Ratios		2016	2015	2014
Gearing	Non-current interest bearing debt / non-current interest bearing debt + equity	0.27	0.24	0.18

(BP Annual Report, 2015 and 2016)

• Earnings per Share:The market analysis of a company is carried out for examining its market attractiveness for investment purpose. The earnings per share ratio represent the portion of a company income that is available to the shareholders and is used for gaining an estimate of its performance. It is calculated by dividing net income available for shareholders with the number of outstanding shares. The earnings per share depicts that both the companies, that are, BP and RDS are shown a negative trend of EPS ratio over the period 2014-2016. The decline in the ratio is sharper in case of BP as compared to that of RDS (Lumby and Jones, 2007).

Description	Formula	ROYAL DUTCH SHELL PLC
Investment ratio		2016	2015	2014
Earnings per share	NPAT/ Number of ordinary shares	1.16	0.62	4.72

(Royal Dutch Shell plc, 2015 and 2016)

Description	Formula	British Petroleum PLC
Investment ratio		2016	2015	2014
Earnings per share	NPAT/ Number of ordinary shares	0.04	(2.12)	1.23

(BP Annual Report, 2015 and 2016)

It can be stated from the financial analysis of both the companies carried out for the period 2014-2016 that their financial growth and development is largely negatively impacted by the period of financial crisis. There is sharp decline in their profitability, liquidity, efficiency and market position. However, it can be said that the negative impact of financial crisis is more on BP as compared to that of RDS (BBC News, 2018). This is because the profitability, liquidity, efficiency and market financial performance of BP have declined largely after the occurrence of the financial crisis. It can be said from the financial ratio analysis that though both companies are recovering from the crisis condition but yet they need to develop and implement strong financial plans for ensuring their sustainable growth and development (Bray, 2018).

The role of strategic management accounting is very important in overcoming the occurrence of financial crisis by promoting the use of fair and honest financial practices by the business entities. The accountants hold the responsibility of developing the general purpose financial statements of the company though the use of accurate and reliable management accounting and costing concepts. This is required to protect the interests of the stakeholders of the business entities such as customers, analysts, investors and shareholders (Avis, 2008).

IAS and IFRS impact on financial statements and ratios

Management accounting helps the company managers in the process of preparing the reports and accounts to gather the accurate and timely financial and statistical information in order to make the short term and long term financial decisions. The purpose of management accounting is to help the managers to make the decisions that persuade the organization goals. Using the managerial accounting information managers can determine what is needed to be sold and how it can be sold. It helps to make the advertising decisions and to determine the future profits that organization can earn using the management information. Management accounting helps to perform the relevant cost analysis that helps in making the costing decision regarding various business processes. Through use of activity based costing, cost managers can allocate the cost to each activity in order to determine what decisions need to be taken for cost control and for total quality management. Decisions like investment in new equipments, diversification in new markets, expansion plans, make or buy decisions can be easily taken through use of management accounting. It helps in forecasting the future trends of the business which is very useful for determining the business future plans. Future cash flows are always a question for almost all the companies and it can be underestimated using the simple methods of management accounting. The process of determining the future cash flows and to know the impact of cash flows on the business is very essential for determining the future performance of the company (Hunt and Fowler, 2009).

Budgets plays very important role in determining the financial health of the company in future. Budgets are required to highlight the financial implications of the plans, determine the resources required to achieve the budget plans and to compare the actual results with the budgeted results in order to determine the variances. Budgets help to determine the targets for the managers that need to be achieved to get the business goals completed. So it can be said that budgets are necessary to overcome the financial crisis as it help the management to make strategies that provides target profits to the company (Weygandt, Kimmel and Kieso, 2009).

The best way to deal with the situation after the financial crises is to apply various costing techniques to generate more profits and to stipulate the overall costs. Under reduce cost method, estimations of various cost applied in each process is being performed and activities that gives the value for money i.e. value added activities are being kept and activities that are not necessary and are not providing any value are being eliminated from that particular process. This cost saving technique helps to save the cost and provide the goods to the customers at some discount. In short, this costing method helps the company to remain in the highly competitive market with ease (Avis, 2008). Both the selected companies are from the oil and petroleum industry where application of cost saving are more difficult for the companies. Both Royal Dutch Shell plc and BP plc have successfully used the cost reduction techniques to reduce the overall cost allocated for the oil production and supply chain process. It allows both the companies to reframe the cost structure and provide the goods and services to customer at much cheaper rate that no other company can provide.

Role of management accounting in decision making

Both Royal Dutch Shell plc and BP plc has make use of technology innovations in their oil refinery process and other processes that has provided them with better quality products in less cost and also the production level has increased to higher level. The investment cost for the technology innovations are allocated in such way that future growth of the company can be maintained and expected financial results are better than the past results. So capital budgeting decision is most important factor for determining the growth of the company after the financial crises (Hunt and Fowler, 2009).

Supply chain management involves around two most important parameters, they are customers and suppliers. Royal Dutch Shell plc and BP plc, both have excellent supply chain management system that helped them to maintain the goods relations with customers through meeting their expectations and also with the suppliers through fulfilling their expectations.

Conclusion

In this report financial performance of Royal Dutch Shell plc and BP plc has been successfully performed for both the companies and it has been found that financial performance of Royal Dutch Shell plc was better than the British Petroleum plc. In either way both companies has performed exceptionally well after the financial crises and it can be easily overviewed through the annual reports of the both the companies published during the last three years. Royal Dutch Shell plc and BP plc have successfully used the strategic management accounting decisions such as cost reduction, capital budgeting, cost allocation etc in their business process in order to survive the financial crises.

References

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Bray, C. 2018. BP to Take $1.7 Billion Charge Over Deepwater Horizon Spill. [Online]. Available at: https://www.nytimes.com/2018/01/16/business/dealbook/bp-oil-spill-deepwater-horizon.html?rref=collection%2Ftimestopic%2FBP%20P.L.C. [Accessed on: 27 February 2018].

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